Markets Insight

April 15, 2013 11:32 am
Markets Insight: The agony and ecstasy of broken markets
Riding the wave of liquidity may eventually end in tears

The Japanese bond purchase programme has already had a material effect on financial prices around the world. It will now alter the global investment landscape by changing the nature and size of capital flows. Yet once the initial excitement passes, the real question will become whether it adds to, or subtracts from, the longer-term stability of the global monetary system.
The Japanese programme is massive: in absolute terms (some $75bn per month); relative to where bond prices stood (the 10-year Japanese government bond interest rate was already very low); and even compared to the Federal Reserve’s QE3 (which involves monthly purchases of $85bn for an economy with a GDP three times larger than Japan’s). Anchored by a 2 per cent inflation objective, the Japanese programme is also slotted to persist for a long time.

Realising this, market participants have already adjusted financial prices. The most dramatic move is in the yen, and justifiably so: unlike the US, where domestic components of aggregate demand would be expected to do the heavy lifting, the Japanese programme’s success depends on its ability to capture market share from other countries.

The currency moves have also been turbocharged by the green light given to Japan by other advanced countries. For now, G7 countries are making a distinction between explicit foreign exchange intervention (still frowned on) and this type of approach to weakening a currency.

Meanwhile, recognising that the economy is in no position to absorb the liquidity injected by the Bank of Japan, markets are also anticipating capital flows out of Japan. The result is a cascading valuation waterfall. It started by benefiting any and all higher-income producing fixed income securities, then pushed higher global equities and other more risk-oriented investment opportunities.

All this happened irrespective of the underlying fundamentals. This is what excites global investors in the short run, but makes them more anxious about the longer term.

It excites them because yet another central bank is now actively involved in creating a significant wedge between sluggish fundamentals and higher financial prices. And so investors continue to ride wonderful liquidity waves that divorce valuations from top line revenue growth and profitability.

Yet it makes investors more anxious because they recognise it may all end in tears if real economies do not respond adequately to central bank policies. Here, the risk is that artificially high asset prices would eventually collapse to levels warranted by fundamentals.

The resolution of this anxiety is not in the hands of central banks alone. It also depends on proper responses by other policy makers, on less obstructive politicians, and on the proper engagement of strong corporate balance sheets. In the meantime, we should expect at least two developments that will add to the twin emotions of excitement and anxiety.

First, Japan’s programme increases the probability that other central banks will be pushed into adopting more expansionary monetary policies. This is particularly the case for economies directly affected by the sharp depreciation of the yen, such as Korea and members of the eurozone. It is also true of those (such as Brazil and Mexico) that experience surges in capital inflows due to Japan’s actions.

Second, the programme will add to worries about market malfunction. This speaks to more than increasing episodes of illiquidity and price gapping already evident in the market for Japanese government bonds. It includes growing concerns about the poor information content of prices in today’s global markets, and how the artificial price signalling distorts the allocation of resources and misaligns incentives (across time, and among different market participants).

Such concerns would be tempered if real economies were to respond quickly and properly to central bank actions. But they are not, and for understandable reasons.

While officials recognise the importance of supporting policies that improve economic responsiveness and longer-term financial viability, these are yet to be put in place. Witness how Congressional dysfunction is paralysing movement on virtually any policy front in the US. And even Japan’s recently announced programme lacks proper specification when it comes to the structural reforms that are essential to increasing nominal GDP in a sustainable fashion.

Global investors are right to be excited by Japan’s bond purchase programme. It has already had a material impact. Yet where it can be a real game changer is in how it alters the dynamic of the longer-term switchover from artificial growth to genuine growth. Here, investors are right to be anxious.

Mohamed El-Erian is chief executive and co-chief investment officer of Pimco

Copyright The Financial Times Limited 2013.

Getting Technical

MONDAY, APRIL 15, 2013         

Gold May Be Near the Bottom


Many technical signs suggest that the price of gold is about to hit the floor, but it's got so much downward momentum it could go straight to the basement.

Gold is getting dusted. After rallying for more than a decade, prices have fallen through a trap door into bear market territory. While this label only tells us what has happened and not what is coming, it does underscore the prevailing trend—down.

The question is whether prices are low enough to suggest a bottom is in. Given the body of technical evidence from trend to momentum, the answer is that it could be. The problem is that, with volatility so high, it is dangerous to place bets in either direction right now.

The carnage began in earnest Friday when gold futures dropped below a key support band between $1,520 and $1,530 an ounce. This was derived from the bottom of a two-year trading pattern (see chart).



Classical chart analysis says that both the long- and short-term trends are down. Using a simple technique of measuring the vertical height of the range and projecting it down from the breakdown point, the $1,275 level is indeed a reasonable goal for the bears. Given that the metal traded at $1,355 Monday morning, that target is already within view.

Moving to a more esoteric method of finding likely support levels, there are two major Fibonacci retracement levels converging in the $1,300 area. Derived from the Fibonacci series of numbers in mathematics, it is not uncommon to find market turns occurring at key percentages of 61.8 and 38.2, as well as at the 50% level.

The bull market began in 2001 with gold trading near $255. A 38.2% pullback from its 2011 peak at $1,923 would be $1,286. And a 50% retracement of the rally that began at the end of the major decline in 2008 would be $1,302. Those two numbers round to about $1,300, and that is not far from the classical downside projection of $1,275 discussed above.

But that does not mean gold will immediately reverse to the upside if it gets down that low. The definition of support is a price level at which the market stops falling, at least temporarily. Demand and supply return to balance, which only suggests prices should stabilize.

Indeed, seasonal factors suggest gold and other precious metals will remain soft through mid-July, according to John Person, President of and co-author of the Commodity Traders Almanac.

Many investors also believe that a stronger economy and stronger U.S. dollar are hurting the metal. Since gold is priced in dollars, these two markets tend to move in opposite directions.

One long-time expert on the gold business disagrees, however. "For all the talk of the recently strong dollaradmittedly in its fourth upturn attempt since its low of 2008why has it been unable to push below the $1.20 level vs. the euro as the world debates whether the euro will even survive?" asked Ian McAvity, editor of the Deliberations on World Markets newsletter.

In other words, McAvity doesn't see the dollar as strong versus the euro over the longer-term, so other factors must be weighing on the price of gold.

This brings us to several factors that suggest gold is already in the final stages of the bear market that the media, and admittedly me, have only recently acknowledged. In a recent Wall Street's Best Minds article on, Tocqueville's chief gold-fund manager, John Hathaway, made the case that gold was nearing a bottom. 

Sentiment is as bearish as it has been in years, according to the Daily Sentiment Index survey of traders compiled by veteran trader Jake Bernstein at Now in the low-single digits on a scale from zero to 100, it tells us that just about all traders surveyed believe gold is still heading lower. From a contrarian point of view, that is bullish—there's no one left to sellalthough Bernstein is quick to point out that sentiment information provides a background, not a trading trigger.

Another sentiment read comes from the Commitments of Traders (COT) report compiled by the Commodity Futures trading Commission (CFTC). Commercial hedgers, which include mining companies and typically the group that usually "gets it right," are traditionally net-short in the futures market. But John Kosar, Director of Research for Asbury Research near Chicago, said that this group is at a historic "least bearish" position. In other words, even as they hedge their future production, they are expressing a belief in higher prices down the road.

India is the world's largest consumer of gold, and one of the more obscure sentiment reads comes from Sushil Kedia, Director of Quantitative Strategy for CIMB Securities in Mumbai. He said nontraditional Indian investorshousewives—are now making many calls to buy gold. In contrast, when gold prices were at their peak they lined up to sell. This is just an observation, not a quantifiable index such as the COT, but in Kedia's years of experience observing demand in the largest gold-consuming nation, this group of investors usually gets it right.

While the trend is indeed still to the downside for gold, the selling we've seen over the past few days does smack of urgency. From traditional technicals such as accelerated bear-market selling on huge volume, to extreme bearishness in sentiment, it does look as if gold is already in the ninth inning of its bear market.

April 14, 2013 6:36 pm
The riddle of Europe’s single currency with many values
The euro is not worth the same amount across the region – Spain and Germany have different currencies

A European Central Bank survey shows that households in northern Europe have a much lower net wealth than those in southern Europe. Average German net assets per household are just under €200,000, while they are €300,000 in Spain and €670,000 in Cyprus. No, this not a typo.

German newspapers screamed that poor Germans are bailing out rich Cypriots. This interpretation is wrong but the truth behind these counter-intuitive findings is even more disturbing. What the survey shows is not wealth differentials but the de facto exchange rates between the eurozone economies. They are not measures of net wealth but of imbalances. And they are enormous.

Since the start of the eurozone, wages and consumer prices have remained broadly constant in Germany. In southern Europe, the general level of wages and prices has increased year-in, year-out

Over the period, this persistent inflation gap has led to a large discrepancy in asset prices. This is why an apartment in Milan costs much more than one in Munich, the city with the highest property prices in Germany. A German euro buys more real estate in Munich than an Italian euro buys in Milan.

In the frantic German debate about these figures, the focus is on median wealth – the statistic that pinpoints the exact middle if one was to rank households by wealth. Looking at the median, the gap becomes even more extreme. In countries with extremely large wealth differentials such as Germany, where a few super-rich people own a large share of the land and real estate, the median is significantly lower than the mean.

Measured in terms of the median, German households occupy the last place among all eurozone countries, with net wealth of a mere €51,000, while the median Cypriot household has net wealth of €267,000. The explanation for this gap is the low property ownership rate in Germany well under 50 per cent. This means that the median German does not own a house, while the median Cypriot or Spaniard does.

The median is the statistic to quote when you want to say that your typical German is poorer than your typical Spaniard. But that is a meaningless statement because it is based on distributions within countries. If you want to compare across countries, it is better to take the mean. The gap is not quite as dramatic but it is still very large.

If mean German net wealth is €200,000 per household and mean Spanish net wealth is €300,000, and if I further believe that the Germans are not really less wealthy as a nation, measured per household, then this gap tells me the minimum extent by which Germany and Spain would need to adjust their real exchange rates.

In truth, the gap is likely to be larger. I happen to believe that your average German household is richer than the average Spanish household. If my assumption is right, then the imbalance between Germany and Spain, as expressed by those figures, would be even higher.

In a monetary union, adjustment can only occur through real movements in wages and prices. Since Germany is not inflating, and is not likely to inflate in the future, I see no chance of that happening, even in the long run. My conclusion is that, in the long run, this adjustment will eventually happen through a nominal change in the exchange rates – which means that somebody has to quit the eurozone or resort to a parallel currency.

To put it another way: if the same unit of account gives us a higher wealth figure for Spain than for Germany, and when you also know that this cannot be true, then there must be something wrong with the unit of account. The other potential solution is that there could be a problem with the data, but I see no fault with the statistical techniques used by the ECB. Maybe they got the house prices wrong.

Statisticians do have difficulty capturing the declines of house prices after bubbles. But this type of discrepancy could not account for such a wide gap.

Indeed, this view also ties in with anecdotal evidence. Looking back to 1999, my own experience was that restaurants and taxis in Berlin were cheaper than restaurants or taxis in Brussels or Paris, but the differences have now become extreme. Curiously, the price gap also affects tradeable goods: European cross-border retail markets are not working efficiently.

This leaves me to conclude that the unit of account is not really the same across the eurozone – that Spain and Germany have a different euro. This is also the reason why I believe southern Europeans have a rational reason to shift their savings to bank accounts in the north – because this would present the only way to preserve the value of their euros in the long run.

Of course, I would not expect the ECB or any other European institution to conclude that the euro is not the same in Germany as in Spain. It is their job to deny this. But the imposition of capital controls in Cyprus has set a precedent. It now has a new currency. I call it the Cypriot euro. According to the ECB’s study, Germany also has its own currency – the German euro – and it is massively undervalued.
Copyright The Financial Times Limited 2013


Updated April 15, 2013, 3:19 p.m. ET

The Fed's Pyrrhic Victory Over Gold


Slick with the viscera of crushed gold bugs, the world's trading floors look even more treacherous than usual.

In one respect, gold's sudden slide—it is down almost 13% in the past two trading days to $1,360.60 an ounce—reflects an age-old story of speculative-excess unwinding. But when momentum falters as drastically as this, it also suggests a shift in the market's groupthink. In this case, it is tempting to call it the triumph of the central bankers.

More than usual, gold prices in recent years have read like a daily critique of monetary policy and the whole notion of fiat currency. Even as rising prices have crimped jewelry sales, investors have stepped in: Their share of gold demand leapt from 10% in 2007 to 29% last year.

Easy monetary policy and regular doses of euro-zone angst have underpinned gold's millenarian appeal. Subzero real interest rates both undermine the attraction of paper currency and mitigate the deterrent of gold's negative yield characteristics.

And yet, and yet…with Cyprus being the latest marginal economy to roil Europe, and Japan's central bank having unveiled a monetary howitzer in comparison to some others' bazookas, gold should be soaring. Plainly, it isn't and has been declining in fits starts since its September 2011 all-time high of about $1,900 an ounce. In addition, long-running correlations between the price of gold and negative real interest rates and the size of the Federal Reserve's balance sheet have broken down in recent months.

In short, fear of an inflationary spike or a 2008-style financial calamity appears to have ebbed. In that sense, Fed Chairman Ben Bernanke and his foreign counterparts have scored. The argument for inflation runs into continuing high unemployment in many developed economies and the risk of deflation in key markets like housing as and when interest rates rise.

Therein lies the potential hangover for those celebrating gold's drubbing. Importantly, it isn't the only commodity under pressure. Indeed, most major industrial commodities barring weather-driven U.S. natural gas and one other commodity have given back most or all of the gains they made in the run-up to last September's announcement of the Fed's latest round of quantitative easing.

Fears of a slowdown in China, reinforced by first-quarter gross-domestic-product data, are trumping inflation concerns. The other commodity still up since September is palladium, reflecting in part stronger sales of U.S. vehicles, which use the metal in their catalytic converters. But even palladium has slipped recently, down 8% so far this month.

In that context, gold seems to indicate that fear of central banks doing too much has morphed into resignation that those efforts might have staved off catastrophe but aren't enough to boost global growth, and thereby inflation, too much in the near term. As central bankers wipe the mess from the soles of their wingtips, they can celebrate a partial victory at best. Stock-market investors should take note.

April 14, 2013

The Antisocial Network


The economic significance of this roller coaster was basically nil. But the furor over bitcoin was a useful lesson in the ways people misunderstand money — and in particular how they are misled by the desire to divorce the value of money from the society it serves.
What is bitcoin? It’s sometimes described as a way to make transactions online — but that in itself would be nothing new in a world of online credit-card and PayPal transactions. In fact, the Commerce Department estimates that by 2010 about 16 percent of total sales in America already took the form of e-commerce.
So how is bitcoin different? Unlike credit card transactions, which leave a digital trail, bitcoin transactions are designed to be anonymous and untraceable.

When you transfer bitcoins to someone else, it’s as if you handed over a paper bag filled with $100 bills in a dark alley. And sure enough, as best as anyone can tell the main use of bitcoin so far, other than as a target for speculation, has been for online versions of those dark-alley exchanges, with bitcoins traded for narcotics and other illegal items.
But bitcoin evangelists insist that it’s about much more than greasing the path for illicit transactions. The biggest declared investors in bitcoins are the Winklevoss brothers, wealthy twins who successfully sued for a share of Facebook and were made famous by the movieThe Social Network” — and they make claims for the digital product similar to those made by goldbugs for their favorite metal. “We have elected,” declared Tyler Winklevoss recently, “to put our money and faith in a mathematical framework that is free of politics and human error.”
The similarity to goldbug rhetoric isn’t a coincidence, since goldbugs and bitcoin enthusiastsbitbugs? — tend to share both libertarian politics and the belief that governments are vastly abusing their power to print money. At the same time, it’s very peculiar, since bitcoins are in a sense the ultimate fiat currency, with a value conjured out of thin air. Gold’s value comes in part because it has nonmonetary uses, such as filling teeth and making jewelry; paper currencies have value because they’re backed by the power of the state, which defines them as legal tender and accepts them as payment for taxes. Bitcoins, however, derive their value, if any, purely from self-fulfilling prophecy, the belief that other people will accept them as payment.
However, let’s leave that strangeness on one side, along with the peculiarmining process — actually a process of complex calculationused to add to the bitcoin stock. Instead, let’s focus on the two huge misconceptionsone practical, one philosophical — that underlie both goldbugism and bitbugism.
The practical misconception here — and it’s a big one — is the notion that we live in an era of wildly irresponsible money printing, with runaway inflation just around the corner. It’s true that the Federal Reserve and other central banks have greatly expanded their balance sheets — but they’ve done that explicitly as a temporary measure in response to economic crisis. I know, government officials are not to be trusted and all that, but the truth is that Ben Bernanke’s promises that his actions wouldn’t be inflationary have been vindicated year after year, while goldbugs’ dire warnings of inflation keep not coming true.
The philosophical misconception, however, seems to me to be even bigger. Goldbugs and bitbugs alike seem to long for a pristine monetary standard, untouched by human frailty. But that’s an impossible dream. Money is, as Paul Samuelson once declared, a “social contrivance,” not something that stands outside society. Even when people relied on gold and silver coins, what made those coins useful wasn’t the precious metals they contained, it was the expectation that other people would accept them as payment.
Actually, you’d expect the Winklevosses, of all people, to get this, because in a way money is like a social network, which is useful only to the extent that other people use it. But I guess some people are just bothered by the notion that money is a human thing, and want the benefits of the monetary network without the social part. Sorry, it can’t be done.
So do we need a new form of money? I guess you could make that case if the money we actually have were misbehaving. But it isn’t. We have huge economic problems, but green pieces of paper are doing fine — and we should let them alone.